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Tenant Leasing Illustrated – March 2013 – Avoiding the Shadow of Duplicative Escalation Charges

Avoiding the Shadow of Duplicative Escalation Charges

The good news after the recent blasting from Nemo (and just when did they start naming snow storms?) is that neither Punxsutawney Phil nor Staten Island Chuck saw his respective shadow this past February 2nd and we are headed to an early Spring.

Groundhog Day also happens to be a big day in my house, and not just because of those furry rodent weather prognosticators. February 2nd is also my wedding anniversary.

That’s right. Each year, my wife steps outside and, if she sees her shadow, she agrees to stay married to me for another year.

Actually, she probably feels like Phil Connors, the Bill Murray character in the classic movie comedy “Groundhog Day“, trapped and reliving each painful day over and over again.

But enough about me. Can a tenant also feel like Robin, er, I mean, Bill Murray, constantly reliving a painful leasing experience?

Yes, particularly with respect to rent escalations.

As we have discussed in past newsletters, tenants are often charged their proportionate share of increases in the building’s real estate taxes and “operating expenses” over an agreed upon base year. This protects the landlord from rising taxes and costs over the term of the lease.

But as we have seen in the past, the definition of terms such as “real estate taxes” and “operating expenses” can have expensive consequences for a tenant.

If a tenant is not careful, a lease can provide for duplicative charges, leaving the tenant reliving a painful payment experience by paying for the same service more than once. That’s enough to make a tenant want to run back into its burrow and pull the blanket over its head.

Avoid the shadow of duplicative charges by addressing the following in your escalation clause:

  • Specifically exclude from the definition of operating expenses any items that are being separately charged under other categories of escalations. This would include real estate taxes, but can also include escalations for insurance expenses and utility or energy expenses which are sometimes charged separately.

You should also specifically exclude any fees and charges excluded from the definition of such other escalations. For example, if the definition of real estate taxes excludes income, franchise, transfer and estate taxes (as is often the case), such taxes should not sneak their way into the operating expense escalation.

  • Avoid duplicative costs under real estate taxes for certiorari proceedings. Certiorari proceedings challenge the assessment of real estate for calculating real estate taxes and can reduce such taxes. Landlords appropriately deduct their legal and other costs in obtaining such reductions before passing on any benefits to you. But many leases both charge you for these costs and deduct these same costs from the amounts to be returned to you.​
  • Include a global prohibition on duplicative charges for all escalations. Your lease should specifically indicate that no cost or expense included in one category of escalations will also be included under any other category of escalations.

Duplication can also be curtailed if the escalation provision requires the use of some equitable accounting standard. Although GAAP or generally accepted accounting principles is generally not applicable to real estate, referencing “sound accounting principles”, consistently applied, and generally recognized or commonly employed in the real estate industry would do the trick.

  • You should similarly exclude charges for which the landlord has already been reimbursed by someone else. Although this may not be exactly the same as paying for these charges more than once, the landlord is receiving payments from more than one party for the same item and these should also be excluded.​

○​  Exclude costs that the landlord incurs in operating an ancillary or specialty service in the building for which users pay a separate charge. For example, a shoeshine stand, newsstand, stationery store, luncheon club, athletic facility, child care center or parking facility. This would include any compensation paid to clerks, attendants or other persons in commercial concessions operated by the landlord.

○​  Items recovered or recoverable by the landlord’s insurance should not be included in operating expenses. You already paid the premiums for such insurance through operating expenses and the landlord is receiving payments from the insurer.

○​  Exclude costs incurred by the landlord in performing work or furnishing services to or for individual tenants at such tenant’s expense. To the extent that such work or service is in excess of any work or service the landlord at its expense is obligated to furnish to all tenants, such special work for a particular tenant should not be included in operating expenses and is also likely to be paid for separately.

○​  Make sure that operating expenses are calculated at the actual net cost (after all rebates and discounts) to the landlord. If the landlord has received the benefit of a rebate or discount, then it is in effect the same as being reimbursed by someone else, and that benefit should be passed on to you.

○​  Equitably apportion costs or expenses shared among various properties. This is a close cousin of the reimbursement examples above. If the landlord is able to spread the cost for certain services across a few of its properties, your building should only be charged its proportionate share of the aggregate costs.

As Phil Connors said about Groundhog Day, “this is one time where television really fails to capture the true excitement of a large squirrel predicting the weather.” Oddly enough, television also cannot do justice to the excitement of lease escalation clauses, but if you address the issues above, you can try to avoid too much excitement when you receive your invoice for escalations.​